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**UNITED STATES**

**SECURITIES AND EXCHANGECOMMISSION**

**Washington, D.C. 20549**

 

**FORM 10-Q**

 

**x****      QUARTERLY REPORT PURSUANT TO SECTION 13 OR15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.**

 

**For thequarterly period ended September 30, 2010.**

 

**OR**

 

**o****         TRANSITIONREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACTOF 1934.**

 

**For the transition period from               to               **

 

**Commission File Number: 1-11388**

 

**PLC SYSTEMS INC.**

(Exact Name of Registrant as Specified in ItsCharter)

 

| **Yukon Territory, Canada**                | ** ** | **04-3153858**                       |
|--------------------------------------------|------------|--------------------------------------|
| (State or Other Jurisdiction of            |       | (I.R.S. Employer Identification No.) |
| Incorporation or Organization)             |       |                                 |
|                                       |       |                                 |
| **10 Forge Park, Franklin, Massachusetts** | ** ** | **02038**                            |
| (Address of Principal Executive Offices)   |       | (Zip Code)                           |

 

Registrant’s telephone number, including areacode: **(508) 541-8800**

 

Indicate by check mark whether the registrant: (1) hasfiled all reports required to be filed by Section 13 or 15(d) of theSecurities Exchange Act of 1934 during the preceding 12 months (or for suchshorter period that the registrant was required to file such reports), and (2) hasbeen subject to such filing requirements for the past 90 days.  **Yes **x**   No **o

 

Indicateby check mark whether the registrant has submitted electronically and posted onits corporate Web site, if any, every Interactive Data File required to besubmitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 ofthis chapter) during the preceding 12 months (or for such shorter period thatthe registrant was required to submit and post such files).  **Yes**  o   **No**  o

 

Indicate by check mark whether the registrant isa large accelerated filer, an accelerated filer, a non-accelerated filer, or asmaller reporting company.  See thedefinitions of “large accelerated filer,” “accelerated filer” and “smallerreporting company” in Rule 12b-2 of the Exchange Act.

 
| Large accelerated filer o                     |   | Accelerated filer o         |
|-----------------------------------------------|--------|-----------------------------|
|                                          |   |                        |
| Non-accelerated filer o                       |   | Smaller reporting company x |
| (Do not check if a smaller reporting company) |   |                        |

 

Indicate by check mark whether the registrant isa shell company (as defined in Rule 12b-2 of the Exchange Act)  **Yes **o**   No **x

 

Indicate the number of shares outstanding of each of theissuer’s classes of common stock, as of the latest practicable date.

 

| **Class**                  | ** ** | **Outstanding at November 5, 2010** |
|----------------------------|------------|---------------------------------------------------------|
| Common Stock, no par value |       | 30,351,092                                              |

 

 

 

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**PLC SYSTEMS INC.**

 

**Index**

 
| Part I.  | Financial  Information: |                                                                                        |
|---------------|-------------------------|---------------------------------------------------------------------------------------------|
|          |                    |                                                                                        |   |
|          | Item 1.                 | Financial  Statements                                                                       |   |
|          |                    |                                                                                        |   |
|          |                    | Condensed Consolidated Balance Sheets (unaudited)                                           | 3 |
|          |                    |                                                                                        |   |
|          |                    | Condensed Consolidated Statements of Operations  (unaudited)                                | 4 |
|          |                    |                                                                                        |   |
|          |                    | Condensed Consolidated Statements of Cash Flows  (unaudited)                                | 5 |
|          |                    |                                                                                        |   |
|          |                    | Notes to Condensed Consolidated Financial Statements  (unaudited)                           | 6 |
|          |                    |                                                                                        |   |
|          | Item 2.                 | Management’s Discussion  and Analysis of Financial Condition and Results of Operations | 12 |
|          |                    |                                                                                        |   |
|          | Item 3.                 | Quantitative  and Qualitative Disclosures about Market Risk                                 | 21 |
|          |                    |                                                                                        |   |
|          | Item 4.                 | Controls and  Procedures                                                                    | 21 |
|          |                    |                                                                                        |   |
| Part II. | Other Information:      |                                                                                        |
|          |                    |                                                                                        |   |
|          | Item  1A.               | Risk  Factors                                                                               | 22 |
|          |                    |                                                                                        |   |
|          | Item  6.                | Exhibits                                                                                    | 23 |

 

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**Part I.         Financial Information**

 

**Item1.        Financial Statements**

 

**PLC SYSTEMS INC.**

CONDENSEDCONSOLIDATED BALANCE SHEETS

(In thousands)

(Unaudited)

 
| ** **                                                                                                                                               | ** ** | **September 30,  2010** | ** ** | **December 31,  2009** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| **ASSETS**                                                                                                                                               |       |                         |       |                        |       |
| Current assets:                                                                                                                                          |       |                         |       |                        |       |
| Cash and cash equivalents                                                                                                                                |       | $                            | 1,325      |                        | $          | 2,686 |   |
| Accounts receivable, net of  allowance of $14 and $24 at September 30, 2010 and December 31,  2009, respectively                               |       | 622                          |       | 720                         |       |
| Inventories                                                                                                                                              |       | 782                          |       | 876                         |       |
| Prepaid expenses and other  current assets                                                                                                               |       | 444                          |       | 505                         |       |
| Total current assets                                                                                                                                     |       | 3,173                        |       | 4,787                       |       |
| Equipment, furniture and  leasehold improvements, net                                                                                                    |       | 40                           |       | 69                          |       |
| Other assets                                                                                                                                             |       | 186                          |       | 186                         |       |
| Total assets                                                                                                                                             |       | $                            | 3,399      |                        | $          | 5,042 |   |
|                                                                                                                                                     |       |                         |       |                        |       |
| **LIABILITIES AND STOCKHOLDERS’  EQUITY**                                                                                                           |       |                         |       |                        |       |
| Current liabilities:                                                                                                                                     |       |                         |       |                        |       |
| Accounts payable                                                                                                                                         |       | $                            | 121        |                        | $          | 336 |   |
| Accrued compensation                                                                                                                                     |       | 104                          |       | 224                         |       |
| Accrued other                                                                                                                                            |       | 303                          |       | 279                         |       |
| Deferred revenue                                                                                                                                         |       | 1,521                        |       | 2,084                       |       |
| Total current liabilities                                                                                                                                |       | 2,049                        |       | 2,923                       |       |
| Deferred revenue                                                                                                                                         |       | 179                          |       | 390                         |       |
| Stockholders’ equity:                                                                                                                               |       |                         |       |                        |       |
| Preferred stock, no par  value, unlimited shares authorized, none issued and outstanding                                                                 |       | —                       |       | —                      |       |
| Common stock, no par value,  unlimited shares authorized, 30,351 shares issued and outstanding as of  September 30, 2010 and December 31, 2009 |       | 93,893                       |       | 93,893                      |       |
| Additional paid in capital                                                                                                                               |       | 838                          |       | 627                         |       |
| Accumulated deficit                                                                                                                                      |       | (93,229                      | )          | (92,464                     | )          |
| Accumulated other  comprehensive loss                                                                                                                    |       | (331                         | )          | (327                        | )          |
| Total stockholders’ equity                                                                                                                          |       | 1,171                        |       | 1,729                       |       |
| Total liabilities and  stockholders’ equity                                                                                                         |       | $                            | 3,399      |                        | $          | 5,042 |   |

 

Theaccompanying notes are an integral part of the condensed consolidated financialstatements.

 

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**PLC SYSTEMS INC.**

CONDENSEDCONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share data)

(Unaudited)

 
| ** **                            | ** ** | **Three Months Ended****September 30,** | ** ** | **Nine Months Ended****September 30,** | ** ** |
|---------------------------------------|------------|--------------------------------------------------------|------------|-------------------------------------------------------|------------|
| ** **                            | ** ** | **2010**                                               | ** ** | **2009**                                              | ** ** | **2010** | ** ** | **2009** | ** ** |
| Revenues:                             |       |                                                   |       |                                                  | ** ** | ** ** |   |   |   |
| Product sales                         |       | $                                                      | 590        |                                                  | $          | 701 |   | $ | 2,101 |   | $ | 2,824 |   |
| Service fees                          |       | 302                                                    |       | 322                                                   |       | 872 |   | 986 |   |
| Total revenues                        |       | 892                                                    |       | 1,023                                                 |       | 2,973 |   | 3,810 |   |
| Cost of revenues:                     |       |                                                   |       |                                                  | ** ** | ** ** |   |   |   |
| Product sales                         |       | 100                                                    |       | 311                                                   |       | 739 |   | 1,059 |   |
| Service fees                          |       | 137                                                    |       | 189                                                   |       | 431 |   | 516 |   |
| Total cost of revenues                |       | 237                                                    |       | 500                                                   |       | 1,170 |   | 1,575 |   |
| Gross profit                          |       | 655                                                    |       | 523                                                   |       | 1,803 |   | 2,235 |   |
| Operating expenses:                   |       |                                                   |       |                                                  | ** ** | ** ** |   |   |   |
| Selling, general and  administrative  |       | 545                                                    |       | 702                                                   |       | 2,184 |   | 2,667 |   |
| Research and development              |       | 115                                                    |       | 180                                                   |       | 482 |   | 594 |   |
| Total operating expenses              |       | 660                                                    |       | 882                                                   |       | 2,666 |   | 3,261 |   |
| Gain on the sale of assets            |       | —                                                 |       | —                                                |       | (98 | ) | — |   |
| Loss from operations                  |       | (5                                                     | )          | (359                                                  | )          | (765 | ) | (1,026 | ) |
| Other income, net                     |       | —                                                 |       | 1                                                     |       | — |   | 3 |   |
| Net loss                              |       | $                                                      | (5         | )                                                     | $          | (358 | ) | $ | (765 | ) | $ | (1,023 | ) |
| Basic and diluted loss per  share     |       | (0.00                                                  | )          | (0.01                                                 | )          | (0.03 | ) | (0.03 | ) |
| Weighted average shares  outstanding: |       |                                                   |       |                                                  | ** ** | ** ** |   |   |   |
| Basic and diluted                     |       | 30,351                                                 |       | 30,351                                                |       | 30,351 |   | 30,351 |   |

 

Theaccompanying notes are an integral part of the condensed consolidated financialstatements.

 

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**PLC SYSTEMS INC.**

CONDENSEDCONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)

 
| ** **                                                                    | ** ** | **Nine Months Ended  September 30,** | ** ** |
|-------------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                                    | ** ** | **2010**                                            | ** ** | **2009** | ** ** |
| Operating activities:                                                         |       |                                                |       |   |   |
| Net loss                                                                      |       | $                                                   | (765       | ) | $ | (1,023 | ) |
|                                                                          |       |                                                |       |   |   |
| Adjustments to reconcile net  loss to net cash used for operating activities: |       |                                                |       |   |   |
| Depreciation and  amortization                                                |       | 29                                                  |       | 75 |   |
| Compensation expense from  stock options                                      |       | 211                                                 |       | 121 |   |
| Change in assets and liabilities:                                             |       |                                                |       |   |   |
| Accounts receivable                                                           |       | 106                                                 |       | (149 | ) |
| Inventory                                                                     |       | 94                                                  |       | 191 |   |
| Prepaid expenses and other  assets                                            |       | 61                                                  |       | 71 |   |
| Accounts payable                                                              |       | (215                                                | )          | (128 | ) |
| Deferred revenue                                                              |       | (773                                                | )          | (890 | ) |
| Accrued liabilities                                                           |       | (96                                                 | )          | (85 | ) |
| Net cash used for operating  activities                                       |       | (1,348                                              | )          | (1,817 | ) |
|                                                                          |       |                                                |       |   |   |
| Effect of exchange rate  changes on cash and cash equivalents                 |       | (13                                                 | )          | 43 |   |
| Net decrease in cash and  cash equivalents                                    |       | (1,361                                              | )          | (1,774 | ) |
| Cash and cash equivalents at  beginning of period                             |       | 2,686                                               |       | 5,026 |   |
| Cash and cash equivalents at  end of period                                   |       | $                                                   | 1,325      |   | $ | 3,252 |   |

 

Theaccompanying notes are an integral part of the condensed consolidated financialstatements.

 

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**PLC SYSTEMS INC.**

NOTESTO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2010

 

***1.******                                     ******Business and Liquidity***

 

PLC Systems Inc. (“PLC” or the “Company”)is a medical device company specializing in innovative technologies for thecardiac and vascular markets.  TheCompany pioneered and manufactures the *CO**2** Heart Laser System* (the “Heart Laser System”) that cardiac surgeons use toperform carbon dioxide (CO2)transmyocardial revascularization, or TMR, to alleviate symptoms of severeangina.  Over the past two years, theCompany has begun initial commercialization outside the United States of itsnewest product, RenalGuard®,which currently represents the Company’s key strategic growth initiative andprimary business focus.  The Companyconducts business operations as one operating segment.

 

RenalGuard is designed to reducethe potentially toxic effects that contrast media can have on the kidneys whenit is administered to patients during certain medical imaging procedures. It isbelieved that allowing contrast media to dwell in the kidneys of certain highrisk patients can lead to contrast-induced nephropathy (“CIN”), a potentiallydeadly form of acute kidney injury. By inducing and maintaining a high urineflow rate before, during and after these medical imaging procedures, theCompany believes the incidence rates of CIN in at-risk patients can be reduced.RenalGuard facilitates this increased urine clearance automatically, enablingthe body to more rapidly void the contrast media, thereby reducing its overallresident time and toxic effects in the kidney.

 

The RenalGuard System consists of aproprietary, closed loop, software-controlled console and accompanying single-usesets.  RenalGuard operates by firstcollecting and measuring patient urine outputs and then in real-time preciselymatching these urine outputs with a prescribed replacement fluid by means ofintravenous infusion. With its automated matched fluid replacement capability,RenalGuard is intended to promote and maintain high urine outputs and minimizethe risk to patients of over- or under-hydration during image-guidedcatheterization procedures where contrast media are routinely administered.

 

The U.S. Food and DrugAdministration (“FDA”) has granted the Company approval to begin a clinicaltrial to study the safety and effectiveness of RenalGuard in the prevention ofCIN; however, the Company has deferred commencement of this study until it cansuccessfully raise additional capital necessary to start and complete thestudy.  The Company must successfullycomplete this study and obtain FDA pre-market approval in order to marketRenalGuard in the U.S.

 

The Company obtained a CE Mark forRenalGuard in December 2007 and began its initial commercialization efforts inthe European Union in Italy in April 2008.

 

The Company has sustained recurringnet losses and negative cash flows from operations for several years. Duringthe nine months ended September 30, 2010, the Company incurred a net loss of$765,000 and used cash in operations of $1,348,000. As of September 30, 2010,cash and cash equivalents were $1,325,000. Management expects that quarterlylosses and negative cash flows will continue during the remainder of 2010.These factors raise substantial doubt about the Company’s ability to continueas a going concern. The accompanying consolidated financial statements havebeen prepared assuming that the Company will continue as a going concern, whichcontemplates the realization of assets and the satisfaction of liabilities inthe normal course of business. The financial statements do not include anyadjustments relating to the recoverability and classification of recorded assetamounts or the amounts and classification of liabilities that might benecessary should the Company be unable to continue as a going concern.

 

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Based upon the current financial condition of theCompany and the expectation of continued quarterly losses during 2010,management is currently investigating ways to raise additional capital that canbe completed in the next few months. In the event the Company is unable toraise such capital in the near term, the Company is unlikely to be able tocontinue its operations.  During thefirst quarter of 2010, the Company engaged a financial advisor to assist theCompany in this effort. In addition, the Company completed a one-thirdreduction of its workforce in February 2010, which it estimates will save theCompany approximately $750,000 annually starting in the third quarter of 2010.As a result of this reduction, in the three months ended March 31, 2010, theCompany recorded a charge of $204,000, comprised of $167,000 of severance payand $37,000 of stock-based compensation expense.  This charge is included in the accompanyingConsolidated Statement of Operations for the first quarter and the nine months endedSeptember 30, 2010 as a component of Cost of revenues, Selling, general andadministrative, and Research and development in the amounts of $66,000, $48,000and $90,000, respectively. As of September 30, 2010, all severance related tothis February 2010 workforce reduction has been paid. The Company will continueto review its other expense areas to determine whether additional reductions indiscretionary spending can be achieved.

 

The Company also believes that the recent announcementsof interim positive clinical data from two independent investigator-sponsoredclinical trials in Italy, MYTHOS and REMEDIAL II, which show RenalGuard to besafe and effective for the prevention of CIN in at-risk patients, present asubstantial opportunity for it to increase its sales and achieve profitableresults in the next few years, provided the Company is able to raise theadditional capital it needs in the near term to sustain its operations andexpand its RenalGuard sales and marketing programs. There can be no assurance,however, that the Company’s plans will be successful or that the Company willbe successful in obtaining the capital necessary to continue its ongoingoperations.

 

On March 20, 2007, the Companyentered into a distribution agreement with Novadaq Corp. (“Novadaq”), asubsidiary of Novadaq Technologies Inc., pursuant to which the Companyappointed Novadaq as its exclusive distributor in the United States for its TMRbusiness.  The agreement amended andrestated the exclusive distribution agreement between the Company and EdwardsLifesciences LLC (“Edwards”), which had been assigned by Edwards to Novadaq onthe same date.  The agreement withNovadaq, which is effective through February 11, 2019, reflects substantiallythe same roles, responsibilities and financial terms as the previous agreementwith Edwards.

 

***2.******                                     ******Basis of Presentation***

 

The accompanying unaudited condensed consolidatedfinancial statements of the Company have been prepared in accordance withgenerally accepted accounting principles (“GAAP”) for interim financialinformation and with the instructions to Form 10-Q and Article 10 of RegulationS-X.  Accordingly, they do not includeall of the information and footnotes required by generally accepted accountingprinciples for complete financial statements. In the opinion of management, all adjustments (consisting of normalrecurring adjustments) considered necessary for a fair presentation have beenincluded. Operating results for the three and nine months ended September 30,2010 are not necessarily indicative of the results that may be expected for theyear ending December 31, 2010.  Thesefinancial statements should be read in conjunction with the consolidatedfinancial statements and footnotes thereto included in the Company’s AnnualReport on Form 10-K for the year ended December 31, 2009.

 

The preparation of financial statements in accordancewith generally accepted accounting principles requires the Company to makeestimates and assumptions that affect the reported amounts of assets and liabilitiesand disclosure of contingent assets and liabilities at the date of thefinancial 

 

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statements, and the reported amounts of revenues andexpenses during the reporting period. Actual results could differ from thoseestimates.

 

***3.******                                     ******Inventories***

 

Inventories are stated at the lower of cost (computed ona first-in, first-out method) or market value and include allocations of laborand overhead.  As of September 30, 2010and December 31, 2009, inventories consisted of the following (in thousands):

 
| ** **       | ** ** | **September 30,****2010** | ** ** | **December 31,****2009** | ** ** |
|------------------|------------|--------------------------------|------------|-------------------------------|------------|
| Raw materials    |       | $                              | 379        |                          | $          | 404 |   |
| Work in progress |       | 9                              |       | 14                            |       |
| Finished goods   |       | 394                            |       | 458                           |       |
|             |       | $                              | 782        |                          | $          | 876 |   |

 

***4.******                                     ******Stock-Based Compensation***

 

In May 2005, the Company’sshareholders approved the 2005 Stock Incentive Plan (the “2005 Plan”).  Incentive stock options are issuable only toemployees of the Company, while non-qualified stock options may be issued tonon-employee directors, consultants and others, as well as to employees.  Under the 2005 Plan, the per share exerciseprice of incentive stock options may not be less than the fair market value of thecommon stock on the date the option is granted. The 2005 Plan provides that the Company may not grant non-qualifiedstock options at an exercise price less than 85% of the fair market value ofthe Company’s common stock.

 

The Company grants stock options toits non-employee directors.  New non-employeedirectors receive an initial grant of an option to purchase 45,000 shares ofthe Company’s common stock that generally vests in quarterly installments overthree years.  Once the initial grant hasfully vested, non-employee directors (other than the Chairman of the Board)receive an annual grant of an option to purchase 22,500 shares of the Company’scommon stock that generally vests in four equal quarterly installments. TheChairman of the Board receives an annual grant of an option to purchase 45,000shares of the Company’s common stock that generally vests in four equalquarterly installments. All such options have an exercise price equal to thefair market value of the Company’s common stock on the date of grant.

 

As a result of the workforce reduction discussed in Note1 in February 2010, options held by terminated employees to purchase a total of498,000 shares of common stock with an exercise price of $0.24 per shareexpired, but were, as part of the Company’s overall severance arrangement withthe terminated employees, replaced by the Company with new options to purchase498,000 shares of common stock at an exercise price of $0.24 per share.  These new options were fully vested upongrant and expire one year from the date of grant. The Company recorded anadditional $37,000 in stock compensation expense related to these grants duringthe three months ended March 31, 2010. In conjunction with the Asset PurchaseAgreement discussed in Note 9, options held by terminated employees to purchasea total of 157,000 shares of common stock with an exercise price of $0.24 pershare were replaced by the Company with new options to purchase 157,000 sharesof common stock at an exercise price of $0.24 per share.  These new options were fully vested upon grantand expire one year from the date of grant and the additional stockcompensation expense recorded during the three months ended June 30, 2010 wasnot material.

 

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During the three months ended June 30, 2010, the Companygranted options to purchase 400,000 shares of the Company’s common stock tonon-employees that vested immediately, and granted options to purchase 112,500shares of the Company’s common stock to non-employee directors which vest infour equal quarterly installments and resulted in $56,000 of stock compensationexpense.

 

Duringthe three months ended September 30, 2010, options held by terminated employeesto purchase a total of 380,000 shares of common stock with an exercise price of$0.24 per share were replaced by the Company with new options to purchase380,000 shares of common stock at an exercise price of $0.24 per share. These new options were fully vested upon grant and expire one year from thedate of grant and the additional stock compensation expense recorded during thethree months ended September 30, 2010 was $15,000.

 

As of September 30, 2010, therewere 537,000 shares of common stock available to be granted under the 2005Plan.

 

The following is a summary of option activity under allof the Company’s stock incentive plans (in thousands, except per option data):

 
| ** **                       | ** ** | **Number  of  Options** | ** ** | **Weighted  Average  Exercise****Price** | ** ** | **Average  Remaining  Contractual  Life (Years)** | ** ** | **Aggregate  Intrinsic  Value** | ** ** |
|----------------------------------|------------|-------------------------|------------|------------------------------------------|------------|--------------------------------------------------------|------------|---------------------------------|------------|
| Outstanding, December 31,  2009  |       | 5,310                   |       | $                                        | 0.25       |                                                   | 4.46       |                            | —     |   |
| Granted                          |       | 1,547                   |       | 0.21                                     |       |                                                   |       |                            |       |
| Exercised                        |       | —                  |       | —                                   |       |                                                   |       |                            |       |
| Forfeited                        |       | (1,105                  | )          | 0.24                                     |       |                                                   |       |                            |       |
| Expired                          |       | —                  |       | —                                   |       |                                                   |       |                            |       |
| Outstanding, September 30,  2010 |       | 5,752                   |       | 0.23                                     |       | 3.43                                                   |       | —                          |       |
| Exercisable, September 30,  2010 |       | 2,038                   |       | 0.24                                     |       | 3.03                                                   |       | —                          |       |
|                                  |            |                         |            |                                          |            |                                                        |            |                                 |            |  |

 

The aggregate fair value of options vested during thenine months ended September 30, 2010 and 2009 was $466,000 and $110,000,respectively.

 

The Company estimates the fair value of stock options onthe day of grant using the Black-Scholes option pricing model, whichincorporates various assumptions including volatility, expected life andinterest rates.  The Company recordedcompensation expense of $36,000 and $211,000 in the three and nine months endedSeptember 30, 2010, as compared to $54,000 and $121,000 in the three and ninemonths ended September 30, 2009.  As ofSeptember 30, 2010, the Company had $99,000 of total unrecognized compensationcost related to its unvested options, which is expected to be recognized over aweighted average period of 1.5 years.

 

The weighted average fair value of options issued duringthe three and nine months ended September 30, 2010 was estimated using theBlack-Scholes model with the following assumptions:

 

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| ** **              | ** ** | **Three Months  Ended September  30, 2010** | ** ** | **Nine Months Ended  September 30, 2010** | ** ** |
|-------------------------|------------|------------------------------------------------------------|------------|---------------------------------------------------------------|------------|
| Expected life (years)   |       | 1.00                                                       |       | 1.00 - 6.00                                                   |       |
| Interest rate           |       | 0.26%                                                      |       | 0.26% - 2.27%                                                 |       |
| Volatility              |       | 236%                                                       |       | 86% - 250%                                                    |       |
| Expected dividend yield |       | None                                                       |       | None                                                          |       |
| Value of option granted |       | $0.04                                                      |       | $0.02 - $0.14                                                 |       |

 

The expected life was calculated in 2010 using thesimplified method. The risk-free interest rate is based on the U.S. Treasuryyield curve in effect at the time of the grant for the expected term period.Expected volatility is based exclusively on historical volatility data of theCompany’s common stock.  The Companyestimates an expected forfeiture rate based on its historical forfeitureactivity.  Actual results, and futurechanges in estimates, may differ substantially from the Company’s currentestimates.

 

*Stock Purchase Plan*

 

The Company has a 2000 Employee Stock Purchase Plan (the“Purchase Plan”) for all eligible employees whereby shares of the Company’scommon stock may be purchased at six-month intervals at 95% of the closingstock price on the last business day of the relevant plan period.  The Company’s stock trades in the over-the-countermarket and, as such, the last sale price of the Company’s stock is deemed to bethe closing stock price for purposes of determining the purchase price for thecurrent six-month period.  Employees maypurchase shares having a value not exceeding 10% of their gross compensationduring an offering period, subject to certain additional limitations.  There was no purchase activity in the threeand nine months ended September 30, 2010 or 2009.  At September 30, 2010, 294,461 shares werereserved for future issuance under the Purchase Plan.

 

***5.******                                     ******Revenue Recognition***

 

The Company records revenue from the sale of TMR kits atthe time of shipment to Novadaq.  TMR kitrevenues include the amount invoiced to Novadaq for kits shipped pursuant topurchase orders received, as well as an amortized portion of deferred revenuerelated to a payment of $4,533,333 from Edwards, the Company’s previousexclusive U.S. TMR distributor, received in February 2004.  This payment was made in exchange for areduction in the prospective purchase price the Company receives upon a sale ofthe kits.  The Company is amortizing thispayment into its Consolidated Statements of Operations as revenue over a sevenyear period (culminating in 2010).  TheCompany determined that a seven year timeframe was the most appropriateamortization period based on a valuation model it used to assess the economicfairness of the payment. Factors the Company considered in developing thisvaluation model included the estimated foregone revenues over a seven yearperiod resulting from the reduction in the prospective purchase price payableto the Company, a discount rate deemed appropriate to this transaction and anestimate of the remaining economic useful life of the current TMR kit design,without any benefit being given to potential future product improvements theCompany may make.  The Company reviewsannually, and adjusts if necessary, the prospective revenue amortization ratefor kits based on its best estimate of the total number of kits likelyremaining to be shipped to hospital customers by Novadaq through 2010. TheCompany recorded amortization of deferred revenue of $289,000 and $867,000 inthe three and nine months ended September 30, 2010 respectively, as compared to$176,000 and $621,000 in the three and nine months ended September 30, 2009respectively, which is included in revenues in the Consolidated Statements ofOperations.

 

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TMR lasers are billed to Novadaq in accordance withpurchase orders that the Company receives. Invoiced TMR lasers are recorded as other current assets and deferredrevenue on the Company’s Consolidated Balance Sheet until such time as thelaser is shipped to a hospital, at which time the Company records revenue andcost of revenue.

 

Under the terms of the Novadaq TMR distributionagreement, once Novadaq has recovered a prescribed amount of revenue from ahospital for the use or purchase of a TMR laser, any additional revenues earnedby Novadaq are shared with the Company pursuant to a formula established in thedistribution agreement. The Company only records its share of such additionalrevenue, if any, at the time the revenue is earned.

 

TheCompany records all other product revenue, including sales of TMR lasers andkits to international customers, sales of RenalGuard consoles and single-usesets and OEM sales of surgical tubes and general purpose CO2 lasers, at the time of shipment, if all otherrevenue recognition criteria have been met.

 

Revenues from service and maintenance contracts arerecognized ratably over the life of the contract.

 

Installation revenues related to a TMR laser transactionare recorded as a component of service fees when the laser is installed.

 

***6.******                                     ******Loss per Share***

 

In the three and nine months ended September 30, 2010and 2009, basic and diluted loss per share have been computed using only theweighted average number of common shares outstanding during the period withoutgiving effect to any potential future issuances of common stock related tostock option programs, since their inclusion would be antidilutive.

 

For the three months ended September 30, 2010 and 2009,5,752,000 and 5,310,000 shares, respectively, and for the nine months endedSeptember 30, 2010 and 2009, 5,752,000 and 5,310,000 shares, respectively,attributable to outstanding stock options were excluded from the calculation ofdiluted earnings per share because the effect would have been antidilutive.

 

***7.******                                     ******Comprehensive Income/(Loss)***

 

Total comprehensiveincome for the three months ended September 30, 2010 was $33,000 as compared toa total comprehensive loss of $353,000 for the three months ended September 30,2009.  Total comprehensive loss for thenine months ended September 30, 2010 and 2009 was $769,000 and $1,010,000,respectively.  Comprehensive income(loss)is comprised of the net income(loss) plus the increase/decrease in currencytranslation adjustment.

 

***8.******                                     ******Warranty and Preventative MaintenanceCosts***

 

The Company warranties its products againstmanufacturing defects under normal use and service during the warrantyperiod.  The Company obtains similarwarranties from a majority of its suppliers, including those who supplycritical Heart Laser System components. In addition, under the terms of its TMR distribution agreement withNovadaq, the Company is able to bill Novadaq for actual warranty costs,including preventative maintenance services, up to a specified amount duringthe warranty period.

 

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The Company evaluates the estimated future unrecoverablecosts of warranty and preventative maintenance services for its installed baseof lasers and RenalGuard consoles and single-use sets on a quarterly basis andadjusts its warranty reserve accordingly. The Company considers all available evidence, including historicalexperience and information obtained from supplier audits.

 

Changes in the warranty accrual were as follows (inthousands):

 
| ** **                        | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|-----------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                        | ** ** | **2010**                                             | ** ** | **2009**                                            | ** ** | **2010** | ** ** | **2009** | ** ** |
| Balance, beginning of period      |       | 12                                                   |       | 20                                                  |       | 7 |   | 10 |   |
| Provision (credit) for warranties |       | —                                               |       | (12                                                 | )          | 5 |   | (2 | ) |
| Balance, end of period            |       | 12                                                   |       | 8                                                   |       | 12 |   | 8 |   |

 

***9.******                                     ******Asset Purchase Agreement***

 

In May 2010, the Company sold to a newly formedcorporation affiliated with its principal OEM customer certain of its OEMsurgical tube assets, comprised principally of inventory, equipment,intellectual property and certain other intangible assets, as well as allnecessary manufacturing documentation needed to perform contract assemblyservices for general purpose CO2 lasers. The total sale price for these assetswas $225,000, of which approximately $154,000 was paid at the time of closing,with the balance due in November 2010. Following the sale, Dr. Robert I. Rudko, who is a part-time officer, adirector and a stockholder of the Company, acquired a minority interest in thecorporation that purchased the OEM assets. In conjunction with thistransaction, in the three months ended June 30, 2010, the Company recorded aninitial gain on sale of assets of $98,000. The portion of the gain related to the note receivable will be recordedwhen cash is received.

 

***10.******                              ******Subsequent Event***

 

On November 5, 2010 the Company entered into anagreement to sell the TMR business to Novadaq. Under terms of the agreement,Novadaq will acquire all of the Company’s assets in the TMR business includingmanufacturing rights, product inventories, equipment, intellectual property,regulatory approvals, clinical data and all documentation related to TMR, for apurchase price of $1 million US in cash, and the assumption of the Company’sobligations under service contracts valued at approximately $700,000.  The transaction is subject to closingconditions, including approval by the Company’s shareholders, the exercise ofdissent rights by shareholders, other than the Company’s directors and officers,holding common stock with a fair market value of less than $200,000, and othercustomary closing conditions.

 

In November 2010, the Company received a grant of$244,000 from the IRS Qualifying Therapeutic Discovery Program.  This amount will be recorded in the Company’sConsolidated Financial Statements during the three months ended December 31,2010.

 

**Item 2.****                      ****Management’s Discussion andAnalysis of Financial Condition and Results of Operations**

 

**Overview**

 

We are a medical device companyspecializing in innovative technologies for the cardiac and vascularmarkets.  We pioneered and manufacturethe Heart Laser System that cardiac surgeons use to 

 

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perform TMR to alleviate symptomsof severe angina. Over the past two years, we have begun initialcommercialization outside the United States of our newest product, RenalGuard®, which currently represents our key strategic growthinitiative and primary business focus.

 

RenalGuard is designed to reducethe potentially toxic effects that contrast media can have on the kidneys whenit is administered to patients during certain medical imaging procedures. It isbelieved that allowing contrast media to dwell in the kidneys of certain higherrisk patients can lead to CIN, a potentially deadly form of acute kidneyinjury. By inducing and maintaining a high urine flow rate before, during andafter these medical imaging procedures, we believe the incidence rates of CINin at-risk patients can be reduced. RenalGuard facilitates this increased urineclearance automatically, enabling the body to more rapidly void the contrastmedia, thereby reducing its overall resident time and toxic effects in thekidney.

 

The RenalGuard System consists of aproprietary, closed loop, software-controlled console and accompanyingsingle-use sets. RenalGuard operates by first collecting and measuring patienturine outputs and then in real-time precisely matching these urine outputs witha prescribed replacement fluid by means of intravenous infusion. With itsautomated matched fluid replacement capability, RenalGuard is intended topromote and maintain high urine outputs and minimize the risk to patients ofover- or under-hydration during image-guided catheterization procedures wherecontrast media are routinely administered.

 

In the U.S., we have received FDAapproval to conduct a pivotal human clinical trial of RenalGuard evaluating itssafety and effectiveness in preventing CIN. This trial is required to support a pre-market approval application,which must be approved by the FDA before we can market RenalGuard in the U.S.We do not intend to commence this pivotal study until we are able to secure sufficientadditional capital to complete the study.

 

We obtained a CE Mark forRenalGuard in December 2007 and began our initial commercialization efforts inthe EU in Italy in April 2008.

 

Novadaq, our U.S. distributor forthe Heart Laser System, is our largest customer, accounting for 97% and 78% ofour total revenues in the three and nine months ended September 30, 2010,respectively and 65% of our total revenues in the year ended December 31,2009.  Our distributor of RenalGuard inItaly, Artech, accounted for 5% and 10% of our total revenues in the ninemonths ended September 30, 2010 and in the year ended December 31, 2009,respectively and 53% and 81% of our RenalGuard revenues in the nine monthsended September 30, 2010 and in the year ended December 31, 2009, respectively.We expect these sales concentrations with Novadaq for TMR sales and Artech forRenalGuard sales to continue for the remainder of 2010.

 

Approximately 98% and 82% of our revenues in the threeand nine months ended September 30, 2010, respectively, and 76% of our revenuesin the year ended December 31, 2009 came from the sale and service of TMRlasers and related disposable kits. We did not sell any HL2 lasers to Novadaqin either the nine months ended September 30, 2010 or the year ended December31, 2009 and they have placed no demand on us to manufacture additional HL2lasers for them for the remainder of 2010. We believe that the number ofopportunities for new TMR laser sales to U.S. hospital customers, andspecifically sales opportunities for our HL2 laser, will continue to be limitedin future quarters as a result of (1) a diminishing number of availablehospitals that have not already implemented a TMR program that are still likelyto do so in the future and (2) continuing financial pressures that hospitalsface, in particular for the funding of new capital equipment purchases, inlight of the ongoing trend of cutbacks in both Medicare and private insurancereimbursement rates for a majority of medical procedures. As such, we expectthat U.S. TMR revenues in future quarters will continue to be entirelydependent upon the sale of TMR kits and service revenues.

 

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As a result, while we do not expect that TMR-related kitand service revenues will change significantly in the near term, we do believeit is more likely they will decline over time. Therefore we will be largely dependentupon our ability to increase our revenues through higher sales of ourRenalGuard product into international markets.

 

Asdiscussed in Note 10 to the Consolidated Financial Statements, we entered intoan agreement to sell the TMR business to Novadaq. If this transaction iscompleted, we do not expect to have future Disposable TMR kit revenues, TMRlaser revenues, or Service Fee Revenues after the transaction is completed.

 

During the first quarter of 2010, we engaged a financialadvisor to assist us with our ongoing efforts to raise additional capital andto explore other strategic options for our RenalGuard program. We need to raisecapital in the next few months, whether through a combination of asset sales,equity investment or other strategic transaction, to continue our operations.

 

Our management reviews a number of key performanceindicators to assist in determining how to allocate resources and run ourday-to-day operations. These indicators include (1) actual prior quarterlysales trends, (2) projected U.S. TMR laser and kit sales for the next fourquarters, as provided by Novadaq in a rolling 12 month sales forecast, (3) projectedfuture sales of RenalGuard consoles and single-use sets, (4) research anddevelopment progress as measured against internal project plan objectives, (5) budgetto actual financial expenditure results, (6) inventory levels (both ourown and our distributors’), and (7) short term and long term projectedcash flows of the business.

 

**Critical Accounting Policies andEstimates**

 

Our financial statements are based upon the applicationof significant accounting policies, many of which require us to makesignificant estimates and assumptions (see Note 2 to the Consolidated FinancialStatements).  We believe that thefollowing are some of the more material judgment areas in the application ofour accounting policies that currently affect our financial condition andresults of operations.

 

***Inventories***

 

Inventories are stated at the lower of cost (computed ona first-in, first-out method) or market value and include allocations of laborand overhead.  A specific obsolescenceallowance is provided for slow moving, excess and obsolete inventory based uponour best estimate of the net realizable value of inventory on hand, taking intoconsideration factors such as (1) actual trailing 12 month sales, (2) expectedfuture product line demand, based in part upon sales forecast input receivedfrom Novadaq and our other customers, and (3) service part stocking levelswhich, in management’s best judgment, are advisable to maintain in order tomeet warranty, service contract and time and material spare part demands.  Historically, we have found our reserves tobe adequate.

 

***Accounts Receivable***

 

Accounts receivable are stated at the amount we expectto collect from the outstanding balances. We continuously monitor collections from customers, and we maintain aprovision for estimated credit losses based upon historical experience and anyspecific customer collection issues that we have identified.  Historically, we have not experiencedsignificant losses related to our accounts receivable. Collateral is notgenerally required. If the financial condition of our customers were todeteriorate, resulting in an impairment of their ability to make payments,additional allowances might be required.

 

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***Research and Development***

 

Research and development costs are expensed as incurred.

 

***Warranty and PreventativeMaintenance Costs***

 

We warranty our products against manufacturing defectsunder normal use and service during the warranty period.  We obtain similar warranties from a majorityof our suppliers, including those who supply critical Heart Laser Systemcomponents.  In addition, under the termsof our TMR distribution agreement with Novadaq, we are able to bill Novadaq foractual warranty costs, including preventative maintenance services, up to aspecified amount during the warranty period.

 

We evaluate the estimated future unrecoverable costs ofwarranty and preventative maintenance services for our installed base of lasersand RenalGuard consoles and single-use sets on a quarterly basis and adjust ourwarranty reserve accordingly.  Weconsider all available evidence, including historical experience andinformation obtained from supplier audits.

 

***Revenue Recognition***

 

We record revenue from the sale of TMR kits at the timeof shipment to Novadaq.  TMR kit revenuesinclude the amount invoiced to Novadaq for kits shipped pursuant to purchaseorders received, as well as an amortized portion of deferred revenue related toa payment of $4,533,333 from Edwards, our previous exclusive U.S. TMRdistributor, received in February 2004. This payment was made in exchange for a reduction in the prospectivepurchase price we receive upon a sale of the kits.  We are amortizing this payment into ourConsolidated Statements of Operations as revenue over a seven year period(culminating in 2010). We determined that a seven year timeframe was the mostappropriate amortization period based upon a valuation model we used to assessthe economic fairness of the payment. Factors we considered in developing thisvaluation model included the estimated foregone revenues over a seven yearperiod resulting from the reduction in the prospective purchase price payableto us, a discount rate deemed appropriate to this transaction and an estimate ofthe remaining economic useful life of the current TMR kit design, without anybenefit being given to potential future product improvements we may make. Wereview annually, and adjust if necessary, the prospective revenue amortizationrate for kits based on our best estimate of the total number of kits likelyremaining to be shipped to hospital customers by Novadaq through 2010. Werecorded amortization of deferred revenue of $289,000 and $867,000 in the threeand nine months ended September 30, 2010, respectively, compared to$176,000 and $621,000 in the three and nine months ended September 30,2009 respectively which is included in revenues in our Consolidated Statementsof Operations.

 

TMR lasers are billed to Novadaq in accordance withpurchase orders that we receive. Invoiced TMR lasers are recorded as other current assets and deferredrevenue on our Consolidated Balance Sheet until such time as the laser isshipped to a hospital, at which time we record revenue and cost of revenue.

 

Under the terms of the TMR distribution agreement, onceNovadaq has recovered a prescribed amount of revenue from a hospital for theuse or purchase of a TMR laser, any additional revenues earned by Novadaq areshared with us pursuant to a formula established in the distribution agreement.We only record our share of such additional revenue, if any, at the time therevenue is earned.

 

Werecord all other product revenue, including sales of TMR lasers and kits tointernational customers, sales of RenalGuard consoles and single-use sets andOEM sales of surgical tubes and general 

 

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purposeCO2 lasers, at the time of shipment, if all otherrevenue recognition criteria have been met.

 

Revenues from service and maintenance contracts arerecognized ratably over the life of the contract.

 

Installation revenues related to a TMR laser transactionare recorded as a component of service fees when the laser is installed.

 

Asdiscussed in Note 10 to the Consolidated Financial Statements, we entered intoan agreement to sell the TMR business to Novadaq. If this transaction iscompleted, we do not expect to have future Disposable TMR kit revenues, TMRlaser revenues, or Service Fee Revenues after the transaction is completed.

 

**Resultsof Operations**

 

Resultsfor the three and nine months ended September 30, 2010 and 2009and the related percent of revenues were as follows:

 
| ** **                                  | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|---------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                  | ** ** | **2010**                                             | ** ** | **2009**                                            | ** ** | **2010** | ** ** | **2009** | ** ** |
| ** **                                  | ** ** | **$**                                                | ** ** | **%**                                               | ** ** | **$** | ** ** | **%** | ** ** | **$** | ** ** | **%** | ** ** | **$** | ** ** | **%** | ** ** |
| ** **                                  | ** ** | **(dollars in thousands)**                 | ** ** |
|                                        |       |                                                 |       |                                                |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Total revenues                              |       | 892                                                  |       | 100                                                 |       | 1,023 |   | 100 |   | 2,973 |   | 100 |   | 3,810 |   | 100 |   |
| Total cost of revenues                      |       | 237                                                  |       | 27                                                  |       | 500 |   | 49 |   | 1,170 |   | 39 |   | 1,575 |   | 41 |   |
| Gross profit                                |       | 655                                                  |       | 73                                                  |       | 523 |   | 51 |   | 1,803 |   | 61 |   | 2,235 |   | 59 |   |
| Selling, general &  administrative |       | 545                                                  |       | 61                                                  |       | 702 |   | 69 |   | 2,184 |   | 74 |   | 2,667 |   | 70 |   |
| Research &  development            |       | 115                                                  |       | 13                                                  |       | 180 |   | 17 |   | 482 |   | 16 |   | 594 |   | 16 |   |
| Total operating expenses                    |       | 660                                                  |       | 74                                                  |       | 882 |   | 86 |   | 2,666 |   | 90 |   | 3,261 |   | 86 |   |
| Gain on the sale of assets                  |       | —                                               |       | —                                              |       | — |   | — |   | (98 | ) | (3 | ) | — |   | — |   |
| Loss from operations                        |       | (5                                                   | )          | (1                                                  | )          | (359 | ) | (35 | ) | (765 | ) | (26 | ) | (1,026 | ) | (27 | ) |
| Other Income                                |       | —                                               |       | —                                              |       | 1 |   | — |   | — |   | — |   | 3 |   | — |   |
| Net Loss                                    |       | (5                                                   | )          | (1                                                  | )          | (358 | ) | (35 | ) | (765 | ) | (26 | ) | (1,023 | ) | (27 | ) |

 
| ** **                                            | ** ** | **Three Months Ended  September 30,** | ** ** | **Increase (decrease)** | ** ** | **Nine Months  Ended September 30,** | ** ** | **Increase (decrease)** | ** ** |
|-------------------------------------------------------|------------|------------------------------------------------------|------------|------------------------------|------------|-----------------------------------------------------|------------|------------------------------|------------|
| ** **                                            | ** ** | **2010**                                             | ** ** | **2009**                     | ** ** | **over 2009**                                  | ** ** | **2010**                     | ** ** | **2009** | ** ** | **over 2009** | ** ** |
| ** **                                            | ** ** | **$**                                                | ** ** | **$**                        | ** ** | **$**                                               | ** ** | **%**                        | ** ** | **$** | ** ** | **$** | ** ** | **$** | ** ** | **%** | ** ** |
| ** **                                            | ** ** | **(dollars in thousands)**                 | ** ** |
|                                                  |       |                                                 |       |                         |       |                                                |       |                         |       |   |   |   |   |   |   |   |   |
| Product sales                                         |       | 590                                                  |       | 701                          |       | (111                                                | )          | (16                          | )          | 2,101 |   | 2,824 |   | (723 | ) | (26 | ) |
| Service fees                                          |       | 302                                                  |       | 322                          |       | (20                                                 | )          | (6                           | )          | 872 |   | 986 |   | (114 | ) | (12 | ) |
| Total revenues                                        |       | 892                                                  |       | 1,023                        |       | (131                                                | )          | (13                          | )          | 2,973 |   | 3,810 |   | (837 | ) | (22 | ) |
| Product cost of sales                                 |       | 100                                                  |       | 311                          |       | (211                                                | )          | (68                          | )          | 739 |   | 1,059 |   | (320 | ) | (30 | ) |
| Service fees cost of  sales                           |       | 137                                                  |       | 189                          |       | (52                                                 | )          | (28                          | )          | 431 |   | 516 |   | (85 | ) | (16 | ) |
| Total cost of revenues                                |       | 237                                                  |       | 500                          |       | (263                                                | )          | (53                          | )          | 1,170 |   | 1,575 |   | (405 | ) | (26 | ) |
| Gross profit                                          |       | 655                                                  |       | 523                          |       | 132                                                 |       | 25                           |       | 1,803 |   | 2,235 |   | (432 | ) | (19 | ) |
| Selling, general &  administrative  expenses |       | 545                                                  |       | 702                          |       | (157                                                | )          | (22                          | )          | 2,184 |   | 2,667 |   | (483 | ) | (18 | ) |
| Research &  development  expenses            |       | 115                                                  |       | 180                          |       | (65                                                 | )          | (36                          | )          | 482 |   | 594 |   | (112 | ) | (19 | ) |
| Total operating  expenses                             |       | 660                                                  |       | 882                          |       | (222                                                | )          | (25                          | )          | 2,666 |   | 3,261 |   | (595 | ) | (18 | ) |
| Gain on the sale of assets                            |       | —                                               |       | —                       |       | —                                              |       | —                       |       | (98 | ) | — |   | (98 | ) | 100 |   |
| Loss from operations                                  |       | (5                                                   | )          | (359                         | )          | 354                                                 |       | 99                           |       | (765 | ) | (1,026 | ) | 261 |   | 25 |   |
| Other Income                                          |       | —                                               |       | 1                            |       | (1                                                  | )          | 100                          |       | — |   | 3 |   | (3 | ) | — |   |
| Net Loss                                              |       | (5                                                   | )          | (358                         | )          | 353                                                 |       | 99                           |       | (765 | ) | (1,023 | ) | 258 |   | 25 |   |

 

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***Product Sales***

 

DisposableTMR kit revenues, the largest component of product sales in the three monthsended September 30, 2010, increased by $108,000, or 23% as compared to thethree months ended September 30, 2009, primarily due to increaseddisposable amortization.

 

DisposableTMR kit revenues, the largest component of product sales in the nine monthsended September 30, 2010, decreased by $108,000, or 7% as compared to thenine months ended September 30, 2009. The decrease reflects lower TMR kitrevenues due to a lower volume of domestic TMR kits sold offset in part byincreased disposable amortization.

 

TMRlaser revenues decreased $226,000, or 92%, in the nine months endedSeptember 30, 2010 as compared to the nine months ended September 30,2009 as a result of no new TMR laser being shipped in the 2010 period. Therewas no laser sales activity in either the three months ended September 30,2010 or 2009.

 

InternationalRenalGuard sales decreased $161,000, or 90%, and $145,000, or 33%, in the threeand nine months ended September 30, 2010, respectively, due to a lowervolume of RenalGuard consoles and single-use sets sold to internationaldistributors.

 

Otherproduct sales decreased $58,000, or 100%, in the three months endedSeptember 30, 2010 as compared to the three months endedSeptember 30, 2009 due to absence of OEM revenue in the 2010 period as aresult of the sale of the OEM business in May 2010.

 

Otherproduct sales decreased $244,000, or 51%, in the nine months endedSeptember 30, 2010 as compared to the nine months ended September 30,2009.  Domestic other product sales increased $58,000 as a result ofincreased OEM manufacturing contract assembly product revenues recognized priorto the sale of the assets of the OEM business in May 2010. Internationalother product sales decreased $302,000 as a result of a one-time sale ofcertain third party equipment required to be supplied along with aninternational Heart Laser System that we recorded as revenue in the firstquarter of 2009. As described above, we sold the assets of the OEM business inMay 2010, and accordingly, we expect other product sales to decreasesignificantly in future periods.

 

Asdiscussed in Note 10 to the Consolidated Financial Statements, we entered intoan agreement to sell the TMR business to Novadaq. If this transaction iscompleted, we do not expect to have future Disposable TMR kit revenues, TMRlaser revenues, or Service Fee Revenues after the transaction is completed.

 

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***Service Fee Revenues***

 

Servicefee revenue decreased $20,000, or 6%, in the three months endedSeptember 30, 2010 as compared to the three months endedSeptember 30, 2009. Domestic service fee revenue decreased $2,000 andinternational service fee revenue decreased $18,000.

 

Servicefee revenue decreased $114,000, or 12%, in the nine months endedSeptember 30, 2010 as compared to the nine months ended September 30,2009. Domestic service fee revenue decreased $55,000 and international servicefee revenue decreased $59,000.

 

***Gross Profit***

 

Grossprofit was $655,000, or 73% of total revenues, in the three months endedSeptember 30, 2010 as compared with gross profit of $523,000, or 51% oftotal revenues, in the three months ended September 30, 2009. The increasein gross margin is due to (1) higher TMR disposable amortization and (2) areduction of OEM related manufacturing cost of sales as a result of the sale ofthe OEM business. These increases were offset, in part, by lower Renal Guardrevenues.

 

Grossprofit was $1,803,000, or 61% of total revenues, in the nine months endedSeptember 30, 2010 as compared with gross profit of $2,235,000, or 59% oftotal revenues, in the nine months ended September 30, 2009.  Gross margin dollars decreased due to loweroverall revenues, most notably from the absence of any Heart Laser Systemsales in 2010 as compared to the one international sale of a Heart Laser Systemand other third party equipment in the first quarter of 2009. The overalldecrease was offset in part by (1) higher TMR disposable amortization and (2) areduction of OEM related manufacturing cost of sales as a result of the sale ofthe OEM business.

 

***Selling, General and AdministrativeExpenses***

 

Selling,general and administrative expenditures decreased 22% in the three months endedSeptember 30, 2010 as compared to the three months endedSeptember 30, 2009.  This decrease is primarily due to lowercompensation-related costs, reflecting the decrease in headcount associatedwith our February 2010 workforce reduction. This decrease was offset inpart by higher corporate legal expenses.

 

Selling,general and administrative expenditures decreased 18% in the nine months endedSeptember 30, 2010 as compared to the nine months ended September 30,2009.  The decrease was due to (1) lower sales expenses in the ninemonths of 2010 as compared to the nine months of 2009 when we incurred $269,000of sales costs associated with the sale of a Heart Laser System and third partyequipment we supplied during the first quarter of 2009, (2) lowercompensation-related costs, reflecting the decrease in headcount associatedwith our February 2010 workforce reduction. These decreases were offset inpart by higher corporate legal expenses.

 

***Research and Development Expenses***

 

Research and development expenditures decreased 36% inthe three months ended September 30, 2010 as compared to the three monthsended September 30, 2009 due to lower compensation-related costs as aresult of our February 2010 workforce reduction.

 

Research and development expenditures decreased 19%inthe nine months ended September 30, 2010 as compared to the nine monthsended September 30, 2009.  The decrease is a result of (1) lowercompensation-related costs as a result of our February 2010 workforcereduction and (2) lower RenalGuard clinical trial costs resulting from thedeferral of the U.S. pivotal study.

 

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***Gain on Sale of Assets***

 

Duringthe nine months ended September 30, 2010, we recorded a gain on the saleof assets of $98,000 related to the OEM business.  We had no gain on saleof assets in 2009.

 

***Other Income***

 

Otherincome consists of interest income earned on our invested cash balances anddecreased $1,000 and $3,000, respectively, in the three and nine months endedSeptember 30, 2010, as compared to the same periods in 2009.

 

***Net Loss***

 

In thethree months ended September 30, 2010, our net loss decreased $353,000, or99%, compared to the three months ended September 30, 2009, due to loweroperating expense and a higher gross profit.

 

In thenine months ended September 30, 2010, our net loss decreased $258,000, or25%, compared to the nine months ended September 30, 2009, due to loweroperating expenses and a gain on sale of assets, offset, in part, by a lowergross margin.

 

***TMR KitShipments***

 

We generally view disposable TMR kit shipments to endusers as an important metric in evaluating our TMR business, although webelieve that specific short-term factors not indicative of long-term trends cansometimes affect shipments of disposable TMR kits in any given quarter.  Domestic TMR kit shipments referenced in thetable below relate to sales by Novadaq to hospital end users.  International TMR kit shipments relate tosales by us directly to our international distributors or hospital end users.

 

Disposable TMR kit shipments to end users were asfollows:

 
| ** **                     | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|--------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                     | ** ** | **2010**                                             | ** ** | **2009**                                            | ** ** | **%  Increase  (Decrease)  Over  2009** | ** ** | **2010** | ** ** | **2009** | ** ** | **%  Increase  (Decrease)  Over  2009** | ** ** |
| Domestic (by U.S. Distributor) |       | 210                                                  |       | 218                                                 |       | (4 | ) | 627 |   | 768 |   | (18 | ) |
| International                  |       | —                                               |       | 5                                                   |       | (100 | ) | 60 |   | 42 |   | 43 |   |
| Total                          |       | 210                                                  |       | 223                                                 |       | (6 | ) | 687 |   | 810 |   | (15 | ) |

 

**Liquidity and Capital Resources**

 

We compete in the highly regulated and competitivemedical device market place where products can take significant time todevelop, gain regulatory approval and then introduce to distributors and endusers. We have historically funded our working capital requirements throughcash received from public and private offerings of our common stock and to alesser extent, through our sales of products and services. We have incurredrecurring quarterly operating losses over the past few years as we have workedto bring our RenalGuard System through development and initialcommercialization efforts outside the United States. We expect such operatinglosses will continue until such time, if ever, that RenalGuard product 

 

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sales increase sufficiently to generate profitableresults.

 

Absent additional outside financing in the next fewmonths, whether through asset sales, equity investment or other strategictransactions, we believe that our existing available cash resources will beinsufficient to sustain our ongoing operations. As a result, a substantialdoubt exists about our ability to continue as a going concern without suchadditional financing, and our independent registered public accounting firm’sreport on our fiscal 2009 financial statements, which is included in our annualreport on Form 10-K for the year ended December 31, 2009, contains anexplanatory paragraph to this effect.

 

Although we are continuing to explore all availableoptions to raise the additional capital we need to continue our operations andimplement our business plan, there can be no assurance that such capital willbe available on terms and conditions acceptable to us.  Should additional financing not be availableon terms and conditions acceptable to us, we will need to take actions thatwill adversely impact our ability to continue to realize assets and satisfyliabilities in the normal course of business. The consolidated financialstatements set forth in this quarterly report on Form 10-Q do not includeany adjustments to reflect the possible future effects of these uncertainties.

 

We believe that the positive interim clinical data fromthe MYTHOS and REMEDIAL II clinical trials, which show RenalGuard to be safeand effective for the prevention of CIN in at-risk patients, presents asubstantial opportunity for us to increase our sales and achieve profitableresults in the next few years, provided we are able to raise the capital weneed in the near term to sustain our operations until such time as we can reachthis level of commercial success.

 

Cash and cash equivalents totaled $1,325,000 as of September 30,2010, a decrease of $1,361,000 from $2,686,000 as of December 31,2009.  We have no debt obligations.

 

Cash used for operating activities in the nine monthsended September 30, 2010 was $1,348,000 due to our net loss, partiallyoffset by non-cash depreciation and amortization expense and non-cashcompensation expense related to stock options. The effect of exchange rate changes was a $13,000 decrease in cash.

 

**Forward-Looking Statements**

 

This quarterly report on Form 10-Q containsforward-looking statements within the meaning of Section 27A of theSecurities Act of 1933, as amended, and Section 21E of the SecuritiesExchange Act of 1934, as amended (the “Exchange Act”). Statements containingterms such as “believes”, “plans”, “expects”, “anticipates”, “intends”, “estimates”and similar expressions reflect uncertainty and are forward-looking statements.Forward-looking statements are based upon current plans and expectations andinvolve known and unknown important risks and uncertainties that could causeactual results to differ materially from those described in the forward-lookingstatements. Such important factors and uncertainties include, but are notlimited to:

 

·                  We will need to, and we may be unable to, raise capital to continue ouroperations, and any such financing will likely be highly dilutive to existingshareholders given our current market capitalization;

·                  Our independent registered public accounting firm’s report on our 2009financial statements included in our annual report on Form 10-K for theyear ended December 31, 2009 contains a going concern opinion, the effectof which is uncertain, but which could be detrimental to our efforts to raisethe additional capital we need on terms that are acceptable to us;

·                  We expect to incur significant net losses in future quarters;

 

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·                  We have a concentration of revenues and credit risk with a singlecustomer, Novadaq, our exclusive U.S. distributor for our TMR products;

·                  We believe it is likely that TMR revenues will decline over time, makingour future prospects highly dependent upon the successful commercialization ofRenalGuard;

·                  If we are unable to raise substantial additional capital, we will not beable to commence our U.S. pivotal clinical trial to study RenalGuard, which isnecessary to obtain FDA pre-market approval to market RenalGuard in the U.S. Wetherefore may never be successful in our goal of demonstrating the value ofRenalGuard in the U.S., which would have an impact on the overall valuation ofthe Company;

·                  Our ability to effectively market RenalGuard outside the U.S. is largelydependent on the results of the MYTHOS and REMEDIAL II investigator-sponsoredclinical trials, which we do not control. We have no assurance that the resultsfrom these two trials will be viewed as clinically meaningful or that they willlead to increased sales of RenalGuard;

·                  We may never be successful in establishing a broad distribution channelfor RenalGuard outside the U.S., and any distribution channel we may establishmay never generate sufficient sales for us to attain profitability;

·                  Our RenalGuard System has only had limited testing in a clinical settingand we may need to modify it substantially in the future for it to becommercially acceptable in the broader market; and

·                  Any potential future modifications required to make RenalGuardcommercially acceptable for the broader market may result in substantialadditional costs and/or market introduction delays.

 

**Off-Balance Sheet Arrangements**

 

None.

 

**Item 3.****                      ****Quantitative and Qualitative Disclosures about MarketRisk**

 

Pursuant to Item 305(e) of Regulation S-K, we arenot required to provide this information because we are a smaller reportingcompany.

 

**Item 4.  Controls and Procedures**

 

***Evaluation ofDisclosure Controls and Procedures***

 

Our management, with theparticipation of our chief executive officer and principal financial officer,evaluated the effectiveness of our disclosure controls and procedures as of September 30,2010.  The term “disclosure controls andprocedures”, as defined in Rules 13a-15(e) and 15d-15(e) underthe Exchange Act, means controls and other procedures of a company that aredesigned to ensure that information required to be disclosed by a company inthe reports that it files or submits under the Exchange Act is recorded,processed, summarized and reported within the time periods specified in theSecurities and Exchange Commission’s rules and forms.  Disclosure controls and procedures include,without limitation, controls and procedures designed to ensure that informationrequired to be disclosed by a company in the reports that it files or submitsunder the Exchange Act is accumulated and communicated to the company’smanagement, including its principal executive and principal financial officers,as appropriate to allow timely decisions regarding required disclosure.  Management recognizes that any controls andprocedures, no matter how well designed and operated, can provide onlyreasonable assurance of achieving their objectives and management necessarilyapplies its judgment in evaluating the cost-benefit relationship of possiblecontrols and procedures.  Based upon theevaluation of our disclosure controls and procedures as of September 30,2010, our chief executive officer and principal financial officer concludedthat, as of such date, our disclosure controls and procedures were effective atthe reasonable assurance level.

 

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***Changes in InternalControl over Financial Reporting***

 

No change in our internal control over financialreporting (as defined in Rules 13a-15(f) and 15d-15(f) under theExchange Act) occurred during the fiscal quarter ended September 30, 2010that has materially affected, or is reasonably likely to materially affect, ourinternal control over financial reporting.

 

**Part II.  Other Information**

 

**Item 1A.****                   ****Risk Factors**

 

Pursuant to the instructions to Item 1A. of Form 10-Q,we are not required to provide this information because we are a smallerreporting company.

 

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**Item 6.****                                  ****Exhibits**

 
| **Exhibit****Number** | ** ** | **Description of Document**                                                                                                                                                                                     |
|-----------------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                  |       |                                                                                                                                                                                                                      |
| 31.1                  |       | Certification of Principal Executive Officer pursuant  to Rule 13a-14(a) or 15d-14(a) of the Securities Exchange Act  of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of  2002. |
|                  |       |                                                                                                                                                                                                                      |
| 31.2                  |       | Certification of Principal Financial Officer pursuant  to Rule 13a-14(a) or 15d-14(a) of the Securities Exchange Act  of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of  2002. |
|                  |       |                                                                                                                                                                                                                      |
| 32.1                  |       | Certifications pursuant to 18 U.S.C.  Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002.                                                                                      |

 

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**SIGNATURES**

 

Pursuant to the requirementsof the Securities Exchange Act of 1934, the registrant has duly caused thisreport to be signed on its behalf by the undersigned thereunto duly authorized.

 
|                                            | PLC SYSTEMS INC. |
|-------------------------------------------------|------------------|
|                                            |             |   |
| Date:    November 15,  2010 | By:              | /s/ James G. Thomasch |
|                                            |             | James G. Thomasch |
|                                            |             | Chief Financial Officer  (Principal Financial Officer and  Principal Accounting Officer) |

 

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**EXHIBIT INDEX**

 
| **Exhibit****Number** | ** ** | **Description of Document**                                                                                                                                                                                     |
|-----------------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                  |       |                                                                                                                                                                                                                      |
| 31.1                  |       | Certification of Principal Executive Officer pursuant  to Rule 13a-14(a) or 15d-14(a) of the Securities Exchange Act  of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of  2002. |
|                  |       |                                                                                                                                                                                                                      |
| 31.2                  |       | Certification of Principal Financial Officer pursuant  to Rule 13a-14(a) or 15d-14(a) of the Securities Exchange Act  of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of  2002. |
|                  |       |                                                                                                                                                                                                                      |
| 32.1                  |       | Certifications pursuant to 18 U.S.C.  Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002.                                                                                      |

 

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